Monday, December 06, 2010

Updated: The savings on the $249 million no-interest loan sought by Forest City Ratner? Likely $191 million (at least) to $314 million over seven years

Part 2 of a series

The effort by the New York City Regional Center (NYCRC), the private investment pool federally authorized to accept immigrant investor funds, and developer Forest City Ratner (FCR) to raise $249 million from 498 Chinese millionaires under the EB-5 immigration program may be legal, but there is ample reason to question whether it will serve the public interest.
Part 1 of this series concerned the seven-year extension available on Phase 1 of the project should Forest City Ratner not repay the EB-5 loan. Part 2 estimated the developer could save at least $191 million. Part 3 examined the sales effort in China, with the arena front and center, even though it's already funded.

Part 4 reported on claims made in China, on video and in person, by public officials supporting the project. Part 5 concerned the value of the development rights, contrasted with those in last year's deal for the Vanderbilt Yard. Part 6 described reasons to think the development rights are overvalued.

Part 7 explained why China is such a popular target for those seeking EB-5 investors
. Part 8 provided another reason why the Nets played exhibition games in China in October. Part 9 cited the curious avoidance of Mikhail Prokhorov during the pitch in China.

Part 10 noted NYCRC's belated announcement of the project in a newsletter. Part 11
described misleading promotion in the Chinese media and by Chinese firms working with the NYCRC. Part 12 covered the proclamations that are part of the pageantry in China.

Part 13 concerned the role of the NYCRC's preferred law firm. Part 14 linked the land loan to a previous one from Gramercy Capital. Part 15 analyzed the use of weasel words and ambiguous language. Part 16 took another look at a web video pitching the project.

The wrap-up and FAQ is here.



[Updated 12/2/11: it looks like it was a low-interest, not no-interest loan, but still savings likely more than $140 million.]

On October 11, I did some very imprecise math, trying to estimate the savings on a $249 million no-interest loan that Forest City Ratner seeks from immigrant investors under the EB-5 program, which trades green cards for supposedly job-creating investments.

I estimated the developer would save nearly $100 million over five years. Actually, the savings would likely be double that, at least, so it's no wonder the developer is pushing very hard to get this deal done.

My estimate needs an update because the loan could last seven years, not five, according to a Recognition Agreement signed by the state; the impact of compounding was not calculated; and a wider range of interest rates should be considered.

Savings: likely $191 million (at least)

A reader more versed in finance has produced the charts below. (Click to enlarge.) The bottom line: over seven years, at a conservative 8.3% interest rate, Forest City Ratner could save nearly $191 million.

(Update: A reader suggests that Forest City Ratner would have to pay some fee or interest rate, and that the NYCRC would want returns not merely from the investors paying fees but from the borrower. That's reasonable. However, because the interest rate noted above is already conservative, the savings estimate remains reasonable. Indeed, South Korean investors are being paid .25%.)

At a somewhat more likely 10% interest rate, FCR could save $244 million--nearly the value of the loan.
At the plausible interest rate of 12%, the developer could save $314 million.

And even at the gentle interest rate of 6.5%, the rate granted in 2009 by the Metropolitan Transportation Authority in the deal to pay off the Vanderbilt Yard over 22 years, FCR could save nearly $141 million.

Of course, should the economy change miraculously, Forest City Ratner might pay back the loan early. But who wouldn't want free money for seven years?

Looking at the numbers

Why is 8.3% a conservative interest rate? Because it represents the average yield for junk bonds, which represent recourse debt, in which the bond holder could have access the the firm's underlying assets or revenues.

Forest City Ratner and parent Forest City Enterprises instead rely on non-recourse debt, which has no such backing. FCE CEO Chuck Ratner in a 9/8/10 earnings release referred to "our exclusive use of non-recourse financing for all of our individual property mortgages."

It's unclear what the rates for non-recourse debt would be over the course of the loan, and Forest City does make a practice of refinancing and extending its debt.

But 10% for now is a very conservative estimate and, according to my source, 12% remains a conservative estimate currently.

Forest City's practices

As Morningstar stated in a 4/22/09 analysis:
As long as the company can cover the interest on these maturing loans, it is in the best interest of lenders to refinance at higher rates instead of taking ownership of the property. Part of Forest City's bargaining power with lenders comes from its ability to hand the keys back to the lender with zero recourse to the core company, outside of a tarnished lender relationship if a mortgage is greater than the value of a given property.
And, if they can wait to refinance at much lower rates, it can all work out.

A more detailed chart (click to enlarge)

The chart below represents the potential costs for a seven-year loan issued on January 1, 2011, Note that it calculates interest based on annual, semiannual, and continuous compounding. The totals represented in the charts above are based on semiannual compounding.

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